Transfer Pricing for Pharma Contract Manufacturing and Licensing Arrangements

Pharmaceutical companies frequently engage in contract manufacturing and licensing arrangements with related parties, both domestic and cross-border. These arrangements are subject to transfer pricing rules under the Direct Tax Code (DTC) 2025. Understanding the transfer pricing implications is essential for pharmaceutical companies to ensure compliance and avoid penalties. This guide analyses the transfer pricing framework for pharma contract manufacturing and licensing arrangements.

The Transfer Pricing Framework

Section 161 — The Arm's Length Principle

Section 161(1) requires that "Any income arising from an international transaction or a specified domestic transaction shall be determined having regard to the arm's length price". Section 161(2) extends this to "Any allowance for any expense or interest".

Section 162 — Associated Enterprise

The pharmaceutical company and the contract manufacturer or licensee become associated enterprises (AEs) under Section 162 when:

• One holds, directly or indirectly, shares carrying not less than 26% of the voting power in the other
• One participates in the management or control or capital of the other
• One has the power to appoint more than half of the board of directors

Section 163 — International Transaction

If the pharmaceutical company or the contract manufacturer/licensee is non-resident, the transaction may constitute an international transaction.

Section 164 — Specified Domestic Transaction

If both entities are resident in India and the aggregate value of related-party transactions exceeds ₹20 crore in a tax year, the transactions may constitute specified domestic transactions.

Common Pharma Related-Party Transactions

1. Contract Manufacturing

• Manufacturing of pharmaceutical products on behalf of the principal
• Toll manufacturing arrangements
• Active Pharmaceutical Ingredient (API) manufacturing
• Formulation manufacturing

2. Licensing Arrangements

• Licensing of intellectual property (patents, know-how, trademarks)
• Royalty payments
• Technology transfer
• Distribution rights

3. Research and Development

• Contract R&D arrangements
• Clinical trial services
• Bio-equivalence studies

4. Marketing and Distribution

• Marketing rights
• Distribution rights
• Co-marketing arrangements

5. Management Services

• Management fees
• Technical services
• Administrative services

Determination of Arm's Length Price

Applicable Methods

Section 165(1) prescribes six methods. The most appropriate method depends on the nature of the transaction:

Transactional Net Margin Method (TNMM)

For contract manufacturing, TNMM is the most widely used method in practice because it is flexible and often easier to apply. Under TNMM:

• The net profit margin realised by the contract manufacturer is compared with that of comparable independent enterprises
• The net profit margin should be calculated in relation to costs incurred

Contract Manufacturing Pricing

For contract manufacturing, the Indian company can look to charge on full cost plus markup basis instead of standard costing. Typical markups for contract manufacturing range between 10% to 20%, but revenue authorities may apply mark-ups in the range of 25% to 35%.

Licensing Arrangements

For licensing arrangements, the royalty rate must be at arm's length. The key considerations include:

• The nature of the IP (patent, know-how, trademark)
• The exclusivity of the license
• The territory covered
• The duration of the license
• The stage of development of the product

Documentation Requirements

Section 171 — Maintenance of Information and Documents

Rule 84(1) prescribes the information and documents to be maintained:

• Description of the ownership structure
• Profile of the multinational group
• Description of the business and industry
• Nature and terms of the international transaction
• Functional analysis
• Method selection and application

Rule 84(2) — Threshold

If the aggregate value of international transactions does not exceed ₹1 crore, the documentation requirements shall not apply.

Section 172 — Report from an Accountant

Every person who has entered into an international transaction or specified domestic transaction shall obtain a report from an accountant and furnish it on or before the specified date.

Special Considerations for Pharma Transactions

1. Characterisation of Activities

The classification of proceeds is a key issue: distinguishing revenue from sale of goods vs. service income (licensing, contract manufacturing, distribution rights) and how each is taxed in India.

2. Intangible Property

Pharma companies often have significant intangible assets (patents, know-how, trademarks). The transfer pricing of IP must consider:

• The development of the IP
• The ownership of the IP
• The exploitation of the IP
• The sharing of risks and rewards

3. Contract Research Arrangements

Contract research arrangements (including clinical trials) require careful transfer pricing analysis. The Indian entity should be compensated for the functions performed, assets employed, and risks assumed.

4. API-Formulation Structures

Pharmaceutical companies with API-formulation structures face significant transfer pricing scrutiny. The transfer pricing strategy must address intercompany transactions between API and formulation entities.

Practical Compliance Strategies

1. Conduct Transfer Pricing Study

• Conduct a functional analysis
• Identify comparables
• Determine the arm's length price
• Document the analysis

2. Maintain Robust Documentation

• Maintain contemporaneous documentation
• Ensure documentation is complete and accurate
• Retain documentation for nine years

3. Consider Safe Harbour

• For contract R&D in generic pharmaceuticals, consider the safe harbour rules (24% margin, ₹300 crore revenue cap)
• For IT services, consider the IT services safe harbour

4. File Report

• Obtain a report from an accountant
• File the report on or before the specified date

5. Monitor Compliance

• Regularly monitor compliance with transfer pricing rules
• Update documentation as necessary
• Review arm's length pricing on an ongoing basis

Consequences of Non-Compliance

Transfer Pricing Adjustment

If the transfer price is determined not to be at arm's length, the Assessing Officer may:

• Adjust the income of the pharmaceutical company or contract manufacturer
• Compute the total income having regard to the arm's length price

Penalties

• Section 442: Penalty of 2% of the value of each international transaction for failure to maintain documentation
• Section 457: Penalty of 2% of the value of the transaction for failure to furnish information

Expert Legal Guidance

Anuj Desai & Associates provides comprehensive legal advisory services on transfer pricing for pharmaceutical contract manufacturing and licensing arrangements. Our direct tax experts help pharma companies understand their obligations, prepare documentation, and navigate the regulatory framework. We assist in TP study preparation, report filing, and representation before income-tax authorities.

---

Disclaimer: This article provides general information and does not constitute legal advice. For specific guidance on transfer pricing or any other direct tax matter, please consult qualified legal professionals.

---

Need Expert Legal Guidance?

Navigating the complex transfer pricing framework for pharmaceutical contract manufacturing and licensing arrangements requires experienced legal counsel. At Anuj Desai & Associates, we provide comprehensive direct tax advisory services, including:

• TP Assessment: Evaluation of transfer pricing obligations
• Documentation: Assistance with TP study and documentation
• Benchmarking: Guidance on comparable selection and analysis
• Representation: Representation before Transfer Pricing Officers

Contact us for expert legal guidance on your pharmaceutical transfer pricing matters.

---